The Reserve Bank of India (RBI) recently confirmed its decision to phase out the Incremental Cash Reserve Ratio (I-CRR). The amount presently held by banks under I-CRR will be released in stages, thereby ensuring a smooth transition and preventing liquidity shock within the financial system.
Phased Implementation and its Necessity
RBI intends to implement the discontinuation of I-CRR in stages. Two stages would involve the release of 25% of the banks’ impounded funds each, while the final stage focuses on releasing the remaining 50% balance. This cautious approach ensures that banks have adequate liquidity to accommodate heightened credit demand during the forthcoming festive season.
What is the Incremental Cash Reserve Ratio?
On 10th August 2023, following the monetary policy announcement and Rs. 2000 notes demonetization, RBI declared that banks must maintain an I-CRR of 10% on their Net Demand and Time Liabilities (NDTL) increase. By September 2023, this requirement was reviewed and measures were adjusted accordingly.
Why was I-CRR Introduced?
The introduction of I-CRR was a temporary countermeasure to manage excess liquidity in the banking system caused by factors such as demonetization of Rs. 2000 banknotes, RBI’s surplus transfer to the government, increased governmental expenditure, and capital inflows. Effective liquidity management was crucial to forestall potential disruptions to price stability and financial stability.
I-CRR’s Impact on Liquidity Conditions
By introducing I-CRR, over Rs. 1 lakh crore of excess liquidity has been absorbed from the banking system. Due to the I-CRR mandate, the banking system temporarily fell into a liquidity deficit on 21st August 2023. However, subsequent liquidity conditions recovered.
Understanding the Cash Reserve Ratio (CRR)
The Cash Reserve Ratio (CRR) is the percentage of total bank deposits that must be maintained in reserves. All banks in India are required to maintain CRR with RBI. Importantly, the CRR helps maintain inflation control, ensures security during emergencies and allows for the necessary funds to be available for customer withdrawals.
Why RBI Used I-CRR for Demonetization
In the case of a sudden liquidity influx such as during demonetization, RBI opted to apply the I-CRR. The tool allowed RBI to address the issue without tampering with other monetary policy areas, ensuring quick and temporary absorption of the excess liquidity.
Monetary Policy Instruments Available to RBI
RBI uses several tools to manage liquidity in the economy. Qualitative tools include moral suasion, direct credit controls, and selective credit controls, which influence banks’ lending and investment behavior. Quantitative tools include Cash Reserve Ratio (CRR), Repo Rate, Reverse Repo Rate, Bank Rate, Open Market Operations (OMOs), Liquidity Adjustment Facility (LAF), Marginal Standing Facility (MSF), and Statutory Liquidity Ratio (SLR).
These measures individually and collectively influence the money supply and liquidity conditions in the banking system. They are designed to help banks meet their short-term liquidity requirements, provide secondary funding sources, and maintain liquidity in the form of approved securities.
It’s important to note that the RBI has chosen to use I-CRR in unique situations, such as demonetization. The decision has been instrumental in managing liquidity without any significant disruption to overall financial stability or monetary policy.
